Could brutal capitalists rip the channel to shreds?

Somewhere along an eight block-long street, running roughly north-west to south-east from Broadway in Lower Manhattan, a rather large penny dropped.

Wall Street has woken up to the channel, in all its lucrative glory.

“Wall Street has finally realised the notion that 75 per cent of world trade flows indirectly, and they are asking experts to highlight value in the market,” outlined Jay McBain, principal analyst of global channels, Forrester.

Enter the supply chain, backed by blockbuster mergers and an endless pot of private equity money.

“We are seeing a new trend in that point solutions across different categories are being combined to create a more holistic, horizontal approach to the channel software industry,” McBain explained.

With Wall Street now engaged in market research — financial jargon for ‘looking at YouTube’ — the channel is fast becoming a target for investors seeking to build a business, hit a billion and make a quick buck.

“It is about time that these sectors get attention by Wall Street,” McBain added. “Because there’s value in the products that partners use with customers. There’s value in products that partners use themselves to run their businesses.

“And there’s value in products that vendors use to manage their channels. This represents many different types of opportunities for investors to explore.”

The end result is that private equity will continue to sweep the channel software space, creating unicorns along the way.

Not to be confused with a mythical animal — typically illustrated as a horse with a single straight horn projecting from the forehead — the unicorn of the modern age is a start-up company valued at more than a billion dollars, typically operating within the software or technology sectors.

Previously, Atlassian flew the Australian flag as the biggest ever float from a home-grown company on US markets, following a heavily over-subscribed IPO valuing the company at over $6 billion on Nasdaq in December 2015.

Fellow past unicorns also include Pure Storage, SimpliVity, Jasper, MuleSoft and Nutanix, joining the list next to LinkedIn, Facebook, Twitter, Alibaba and WhatsApp among others.

Market metrics

During the past 12 months, 197 private technology companies around the world were valued at more than $1 billion, according to CB Insights. Collectively, these businesses are worth approximately $679 billion, raising approximately $142 billion.

In reaching, and then surpassing the billion-dollar mark, businesses stand to smash through a financial glass ceiling and into a new world of increased investment.

“Yes, it’s arbitrary because it’s a big round number,” acknowledged Slack Technologies CEO, Stewart Butterfield, when speaking to Forbes in 2015. “It does make a difference psychologically. One billion is better than $800 million because it’s the psychological threshold for potential customers, employees and the press.”

Cash over channel

In the world of private equity where money does in fact live on trees, investors are upping the ante in the pursuit of packaged powerhouses, powerhouses capable of attracting the attention of larger coffers.

In short, this is not a channel play or technology venture, rather a simple exercise in making money, and fast.

“When private equity gets involved, these guys are capitalists first and they couldn’t care less about the channel,” McBain cautioned. “It’s all about making money and that’s what makes channel partners a little bit weary.”

As a result, the vendor now comes under the same roof as Autotask, which has been owned by Vista since June 2014, combining back-up and disaster recovery solutions with IT service management capabilities.

From a logistics perspective, the joint entity has approximately 1,300 employees with offices in nine countries, bolstered by 13,000 customers servicing more than 500,000 SMBs in 125 countries worldwide.

“Autotask-Datto has been made into a significant vendor, but what private equity does is make a unicorn,” McBain added. “They want a company that is worth a billion dollars and to achieve that, investors will combine companies such as Autotask-Datto.

“Once they have built this entity, they will try to get a Salesforce, IBM or Oracle type of business to go out and buy it. That’s the play.

The channel is irrelevant, they only care about the dollar. If they can convert $500 million of cash into a billion dollars of cash within the space of a few years, then they will actively pursue this path.”

Good and bad news

Such activity, which is forecast to increase during the next 12 months, presents both “good and bad news” for the channel.

“The good news is that private equity firms have tonnes of money so if a business needs a product to be improved to turn into a unicorn, then that won’t be a problem,” McBain said.

“If the buyers come back and say, we’re not going to buy Autotask- Datto for example, because the software is still five years away. Then guess what? These guys will put in the money to collapse that five years into one.

“And they will hire the absolute best programmers on the planet and pay them endless amounts of money to accelerate the timeline.”

Motivated by the need to secure a quick return on investment, McBain said private equity firms will stop at nothing to fast-track growth and innovation in the pursuit of a sale. But such speed comes with challenges for the channel, as the outside party pursues a strategy capable of ripping the interior fabric of an organisation to shreds.

“They are going to put in place a management team that works,” McBain said. “And in many cases that means the original founding team goes. They are good people but perhaps they are in a little over their heads which means private equity will start hiring people from Fortune 500 organisations.

“They want people who know how to run a billion-dollar business.”

In looking back through the annals of channel history, McBain acknowledged that combining companies and capabilities is “nothing new”.

Since 2015, ConnectWise has acquired ScreenConnect and HTG, while Kaseya gobbled up Unigma, Vorex and Zyrion within five years.

“Combination plays aren’t new but that was using internal and founder money to get those transactions over the line,” McBain recalled. “Once you get Wall Street involved, it’s cash.”

Take SolarWinds, which acquired LOGICnow in June 2016, backed by a consortium of investors led by Insight Venture Partners.

Continuing the trend, Thoma Bravo LLC, a leading private equity investment firm, also entered the market through acquiring Continuum in June 2017.

“Founders are cashed out and because of that they could be fired at any minute,” McBain warned. “Most don’t own 51 per cent of their companies anymore which places them in an exposed position.

“Being a founder is fine providing you are tracking along nicely and private equity is on course to make money.

“The second that one or two quarters go by and the business stop tracking well, regardless of economic and market conditions, they will make the changes necessary. They are brutal capitalists.”

Creating a knock-on effect in the process, the ramifications for the channel will come through a management structure that isn’t enamoured by indirect business, doesn’t value loyalty and isn’t afraid to break up long-standing partnerships.

“It’s bad news for partners,” McBain said. “All of the people that really grew the business through the years and really loved and supported the channel are going. These businesses will turn on a dime.

“Because if private equity does the numbers and they discover that they need to go after bigger partners and Fortune 500 companies, then the channel will suffer.

“They won’t care about the relationships that got them where they are today, they just want to reach $1 billion. This is the impact.”